Magazine

Nightmare Mortgages

September 24, 2006

Housing stories tend to fire people up these days, but we were surprised by the response to our Sept. 11 cover story, "How Toxic is Your Mortgage?" The article centered on option ARMs, extremely risky and complicated loans that have gained popularity in recent years. It cast a critical eye on the mysterious inner workings of the mortgage industry -- and in turn stirred the passions of bankers, mortgage brokers, accountants, investors, and consumers alike. Comments started pouring in as soon as we posted the article on our Web site on Aug. 31.

Option ARMs were created a quarter-century ago to appeal to wealthy borrowers. But as the recent housing boom wore on, bankers and brokers began marketing the risky loans as affordability tools for the masses. The lenders profited nicely, as did the hedge funds that bought the loans. But borrowers, we argued, will suffer disproportionately when those loans blow up.

Many readers expressed outrage that banks are able to book the full amount of an option ARM payment as revenue even when they receive much less than that amount. Some readers were offended by what they deemed our broad-brush characterization of mortgage brokers. And others said we didn't heap enough responsibility on borrowers, who should have known better.

Here's a sampling of the feedback we got.

I'm a banker, and I consider [option ARM loans] irresponsible lending. People should be steered toward long-term, fixed-rate debt, and if they can't afford it they should stay out of the market. I'm in investment banking/capital markets and don't feel a twinge of guilt if I trade around someone and take their money. But these [mortgage]products are deceptive and should not be offered to the general public. -- David Coker, London

It is not clear to me how long regulators can stand on the sidelines and do nothing about option ARM lending. Clearly, the long-term effects are detrimental to consumers, communities, banks, and investors alike. Why wait for yet another S&L crisis to cost taxpayers big bucks? -- Michael R. Adamian, Elburn, Ill.

There's no such thing as a free ride. Whether it's tech stocks, ARMs, or oil, the market eventually squeezes out the excess. The only thing that changes is the color of the package. -- screen name: Barinr (BusinessWeek.com)

As a mortgage broker, I was appalled by your article. True, we are "commission hungry," as that is our only source of income, like so many other employees of the real estate industry. And yes, we do try and "make the sale," like all other salespeople who are commission-based, and sometimes highlight the benefits of certain products and "play down" the disadvantages. But to present the entire industry as toxic is going a little too far. -- Oren Orkin, Chicago

Yes, there are bad apples in the industry, and they need to be called to account. But to paint us all as money-hungry predators looking to pad our wallets at the expense of the home-buying public is like equating all journalists to [discredited former New York Times reporter] Jayson Blair. -- David "Skip" Dyer, ProActive Mortgage, Cary, North Carolina

I am a mortgage broker, and I absolutely hate the option ARM. It was meant to be a niche product, and it is a shame that it has become so popular. Greedy brokers who care only about commissions are the ones pushing them on people. Many loan officers don't even fully understand the option ARM loans they are pushing, or the risks. -- Scott Lafferty, Saratoga Springs, Utah

I hate to say it, but most of the people mentioned in this article are fools. You "didn't expect" the 1% rate to go up? Well, then, you are a moron. Option ARMs didn't show up overnight. They have been around for years, suckering people into buying things they can't afford. If you can't afford a traditional 30-year mortgage, buy a cheaper house. -- Bryan R. Beal, University Heights, Ohio

The problem I see here is everyone's fault -- the lenders for pushing these loans down people's throats and home buyers who got caught up in the frenzy. -- screen name: Modog (BusinessWeek.com)

To blame the borrower for getting screwed is preposterous. Naive, perhaps, in the belief that the lender has their best interests at heart. But as I tell many I counsel, if it sounds too good to be true, it is. -- screen name: Counselor (BusinessWeek.com)

Give me a break! The option ARM is a great wealth management tool -- if you have a significant amount of future income coming, like a large bonus or commission, and can pay down a large amount of principal with that future income. Once you pay down the principal, the payment amounts are recalculated lower. Using the bank's money to buy time at a 1% rate for a soon-to-arrive cash infusion is a great wealth-building strategy if smartly utilized. -- Bruce Hiatt, Realtor, Las Vegas

I would be interested in some explanation as to how the Financial Accounting Standards Board could intellectually justify accrual accounting standards with option ARMs, given the attendant risks. -- Michael Horwitz, Austin, Tex.

How do [banks] plan to cash in on this phantom money, owed by people who can't afford to pay? Are they just going to pass on the hot potato until the last person left holding it gets burned fingers? -- Julian Morrison, Reading, England

As a CPA, I am offended by the presumption that there is a problem with the accounting for deferred interest. The author implies that the accounting industry is to blame for money not yet paid being recognized as income by the banks. This happens in every industry, except that in other industries it is not called deferred interest, but rather accounts receivable. Does the author mean to say that all accounts receivable transactions are phantom profits? As for who to blame for the problem: the banks, for extending the credit, and the homeowners, for not understanding the contracts they signed. -- Michael Rhyce, New Fairfield, Conn.

The intent in all cases is to show profits on the books that do not exist. This is a conscious and willful attempt to mislead investors as to the profitability of their operations. -- John Hunter, Winter Park, Fla.

This is one of the most massive scams I have seen. I truly fear the consequences. -- Chuen Ng, Lancaster, Calif.

Why weren't you writing articles like this in 2002, 2003, 2004, when it was obvious to people who understood what was going on (meaning your reporters) that this was a ticking time bomb? The media had a large role in remaining silent about an obvious problem and shaping the housing mania. -- David Dalka, Chicago

I am one of those homeowners who could not resist the urge to buy a home two years ago. My ARM loan will expire in October, and the lender has already informed me of the interest and payment increase coming in November. I guess I could refinance, but will I qualify for a conventional loan? It's definitely a rude awakening. -- screen name: ARMnoob (BusinessWeek.com)

This era of financing is [reminiscent] of the early 1980s. History will repeat itself with defaults, foreclosures, and bankruptcies. Only this time around, the '80s will look like a cakewalk. I predict it will begin in the second quarter of 2007 and last well into early 2009. Fasten your seat belts -- I've never seen a soft landing in 30 years of being in this business. -- screen name: Mickie (BusinessWeek.com)